In the past six months, we’ve seen four rate hikes by the People’s Bank of China (PBOC), and rather than continuing to decline as everyone had expected, Chinese A-Share stocks are now rallying. What gives?
Well, I think the stock market feels that the end of the PBOC rate hikes is near. The Chinese economy had been growing at an unsustainable pace — an alarming 11.9% in the first quarter of 2010 — so the monetary tightening that came in the form of short-term rate hikes, reserve requirement increases, and lending quota cuts was to be expected.
This naturally caused mainland Chinese equity indexes to underperform, as the tightening applies extra pressure on financial stocks and property developers. Yet even with those actions, there is still no evidence of the crash in the Chinese commercial and residential property markets that had been feared by bears in the camp of Jim Chanos and the like.
There are certainly issues that the Chinese authorities would like to address — such as the rapid growth of shadow banking lending that is outside the control of the PBOC. This type of lending is facilitated by Chinese trust companies that repackage loans to be sold as wealth management products to wealthy Chinese customers. Deposit rates in China are still negative in real terms, so the appeal of such products with higher yields is understandable.
As best can be estimated, such trust companies now control about 2.5 trillion yuan of the total 48 trillion yuan loan book of the Chinese financial system. While this is an issue, it also appears that China is far from the excesses that we saw in the United States in 2007, a time when the shadow banking securitization industry had become larger than the banks themselves when measured by the amount of credit provided.
So I have high hopes we will be able to avoid the rampant securitization of otherwise questionable loans like the kind we had in the United States in 2006 and 2007, especially since the Chinese authorities are very mindful of the likely results of a busted credit bubble with the global financial crisis still fresh in the minds of world leaders.
How to Play the Monetary Tightening Finale
Financials and real estate plays sound controversial, but those are exactly the types of stocks that I expect to lead in the coming rally as the PBOC gets out of the way. This is because their business had been constrained by the central bank, yet the Chinese economy continued to grow at a remarkable pace. The earnings power of financials and real estate plays should feel the biggest catapult effect toward the end of 2011.